Capital structure of a firm is
its assets through the combination of debt and equity. They have been used to
build and grow the asset. A good logical capital structure portrays the quality
work of financial management and it represents a firm’s value. Similarly, a bad
logical capital structure can reduce the value of the firm. Based on information collected and its transparency, the investor can make a decision whether to
invest in the firm or not.
Objective of a firm is to
maximise the value. To meet this objective, a firm may need to change its
financial structure if necessary. Being a firm’s value is built on its assets;
in the event of financial distress or to generate more profit margins, the management
team has to review the capital structure of the firm and may need to consider
the refinancing.
Refinancing can be either debt or
equity. The ability to select the right choice is very important for a firm.
Some financial leverages are beneficial and some are not. The more debt
financing a firm uses, the higher its financial leverage. The risk is the cost
of capital of a firm. The high interest payment can affect a firm’s earning per
share. This is against a firm’s objective to maximise the wealth and it is affecting
the stockholder.
Here, I have learned about
Modigliane and Miller’s Capital Structure Theories that in perfect markets, it
does not matter what capital structure a company uses to finance its
operations. However, in real world, there are changes of taxation, changes of
interest rate, cost of bankruptcy and etc are affecting to the firm’s value. In
order to understand the intrinsic value of a firm, the analysts and investors
use WACC Weighted Average Cost of Capital as a decision tool that will analyse
the minimum rate of return at which a firm can produce for its investor.
Having the risk in debt financing
does not mean the best option is to equity financing. The perspective between
the firm and investors are different. Issuing new share appears to be promising
as there is no liability to pay high interest rate but fall of EPS is not
attracting to investor. Furthermore, issuing new equity depress the stock value
in two ways; it t increases the supply, thus lowering the price; and it "signals"
that management thinks the stock price is high relative to its true value.
Conversely, a company that repurchases some of its own stock signals an
undervalued stock. Buying stock back, the theory goes, will reduce the supply
and increase the price (Milken, 2014).
UK Premier Food has recently
announced a plan to change of its Capital Structure to meet the long burden
debt problem (UK.reuters.com, 2014). After announcement on 4th March 2014, the
shares were down 5 percent to 133 pence at 0944 GMT. However, the management
said that the capital refinancing plan is subject to approval by shareholders
at a meeting on March 20. The management’s choice of refinancing method is
mixed, partly equity and partly debt. The plan is to raise a total of 353 million
pounds via a placing of new shares and a rights issue, and a further 475
million pounds through a bond issue.
They claimed that their
refinancing package is designed to liberate. In fact, issuing new equity will
reduce the level of the ownership of the shareholder and affecting the level of dividend they may
receive in future. To appease the shareholders, the management of Premier Food
are saying they have made pre-agreement with the lenders to pay a dividend to
shareholders when the ratio falls below 3 times.
Overall, it appears the
shareholders are losing both the level of ownership and dividend. The present
situation of share price fall hope to be not lasted long and the hiring of cost
of advisory group for refinancing may not significantly reduce the capability
of giving dividend.
In conclusion, reviewing capital
structure is good for the firm’s financial health but the most important thing
is to build a good logical capital structure that can enhance the business success
both for the firm and stakeholders.
Reference:
Milken, M. (2014). Why
Capital Structure Matters. [online]
Retrieved from: http://online.wsj.com/news/articles/SB124027187331937083
[Accessed: 28 Mar 2014]
Uk.reuters.com. (2014). Premier
Foods unveils $1.13 billion pound refinancing plan | Reuters. [online] Retrieved from:
http://uk.reuters.com/article/2014/03/04/uk-premier-foods-refinancing-idUKBREA230HM20140304
[Accessed: 28 March 2014].
Lecture Notes
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